As the markets evidently expected,


(see the recent plunge in the gold-silver ratio), Fed chief Bernanke expanded on the Fed's 'policy options' in his Jackson Hole speech today. While the speech as a whole once again seems very useful for inducing sleep, it contains a whole chapter on 'further easing' that the Fed could commit to, i.e. various methods of printing more money. The one thing they won't allow to happen is falling prices. So if you were hoping that the deflationary era would lead to say, a falling groceries bill, lower health care costs, or even lower education costs – sorry, the Fed won't let that happen.



Instead of people's savings going a bit further during the depression, they will have to contend with still higher prices if the Fed gets its way.

The relevant passage from Bernanke's speech is this one:


“First, the FOMC will strongly resist deviations from price stability in the downward direction. Falling into deflation is not a significant risk for the United States at this time, but that is true in part because the public understands that the Federal Reserve will be vigilant and proactive in addressing significant further disinflation. It is worthwhile to note that, if deflation risks were to increase, the benefit-cost tradeoffs of some of our policy tools could become significantly more favorable.”


So in short, the misguided 'price stability' policy that is the main reason for the boom-bust sequence that has now led to a secular economic contraction (a.k.a. depression) is certainly going to continue. Bernanke would rather destroy the currency than allow prices to fall. What is the 'benefit-cost trade-off' Bernanke talks about? He means the potential cost of inflating the money supply willy-nilly, which in his view consists of 'inflation expectations becoming un-anchored'. We would point out here, the Federal Reserve and its policies are for society as a whole all cost and no benefit whatsoever. The dollar has lost 96% + of its purchasing power since the Fed was founded, while it had been stable in the 110 years preceding the creation of the central bank. Economic growth was far greater before the Fed came into being, and real incomes rose strongly, whereas since the early 1970's, when the United States cut the last tie between the dollar and gold, real per capita incomes have actually managed to decline.

So the cost-benefit equation Bernanke invokes here is simply complete nonsense. There is no benefit to society to be had at all from increasing the supply of money. It only benefits a small group of first receivers of the newly created money, but no-one else. By injecting additional money from thin air into the economy, the Fed sets into motion 'exchanges of nothing for something', as Frank Shostak likes to put it. This is so, because the Fed's new money is created by a few taps on a keyboard, at zero cost. No genuine production has taken place to 'back' these new fiduciary media. However, the money will then be used to bid for real resources. Thus, 'nothing' (money from thin air) is exchanged for 'something' (real resources). The creation of additional money also temporarily (and this 'temporary' factor can become very extended if the inflationary policy is pursued incessantly) lowers the interest rate below that dictated by time preferences, and thus sends false signals to capitalists and entrepreneurs about the amount of savings available to finance production, and the extent of future demand. What ensues is malinvestment, and the consumption of scarce capital.

In short, Bernanke promises he will do everything to structurally weaken the economy further by creating even more money from thin air than he already has. There is no benefit that can possibly flow from this policy.

Let us look at some of the proposed activities the Fed may undertake. This is mainly interesting insofar as it disguises the obvious fact of what is going to be done – namely the printing of more money – by the use of numerous euphemisms and of course by dint of the methodology involved in creating a debt-based money, which as we noted previously is very much akin to the old scam-game of Three Card Monte.

Bernanke again:


“I believe that additional purchases of longer-term securities, should the FOMC choose to undertake them, would be effective in further easing financial conditions. However, the expected benefits of additional stimulus from further expanding the Fed's balance sheet would have to be weighed against potential risks and costs. One risk of further balance sheet expansion arises from the fact that, lacking much experience with this option, we do not have very precise knowledge of the quantitative effect of changes in our holdings on financial conditions. In particular, the impact of securities purchases may depend to some extent on the state of financial markets and the economy; for example, such purchases seem likely to have their largest effects during periods of economic and financial stress, when markets are less liquid and term premiums are unusually high. The possibility that securities purchases would be most effective at times when they are most needed can be viewed as a positive feature of this tool. However, uncertainty about the quantitative effect of securities purchases increases the difficulty of calibrating and communicating policy responses.”


Yes, one of the great difficulties central planners face everywhere and always is that they haven't the foggiest idea about what they are doing and what the  effects of their actions will be. How did the hyper-inflation episodes of the past happen? Not in a single instance did the central bank set out to produce a hyper-inflation event. There was always a reason as to why the planners thought their inflationary policy could not possibly get out of control. The main problem is that in order to appreciate the dangers, you have to first understand on a theoretical level what the dangers actually are. Bernanke has no idea.


“Another concern associated with additional securities purchases is that substantial further expansions of the balance sheet could reduce public confidence in the Fed's ability to execute a smooth exit from its accommodative policies at the appropriate time. Even if unjustified, such a reduction in confidence might lead to an undesired increase in inflation expectations. (Of course, if inflation expectations were too low, or even negative, an increase in inflation expectations could become a benefit.) To mitigate this concern, the Federal Reserve has expended considerable effort in developing a suite of tools to ensure that the exit from highly accommodative policies can be smoothly accomplished when appropriate, and FOMC participants have spoken publicly about these tools on numerous occasions. Indeed, by providing maximum clarity to the public about the methods by which the FOMC will exit its highly accommodative policy stance–and thereby helping to anchor inflation expectations–the Committee increases its own flexibility to use securities purchases to provide additional accommodation, should conditions warrant.”


This paragraph really takes one's breath away for a moment. An increase in inflation expectations could become a benefit? As we said above, falling prices are verboten according to Bernanke. As to the 'smooth exit' from the Fed's accomodative policies – they have just killed the 'exit strategy' at their August meeting, as anyone who was paying attention knew they eventually would. There will never be an exit, smooth or otherwise. If any reader can point us to a past time period when the Fed's balance sheet actually shrank, we'd really like to hear about it. The phrase we highlighted above – aside from showing that the bureaucrats suffer from a serious case of hubris – can be translated as follows: 'By pretending that we can and will eventually actually tighten policy, we can print all the more money without anyone getting to wise to the fact that the inflationary policy is here to stay'. This is in effect what Bernanke means. As we will see, when the time of inflation expectations becoming decidedly 'un-anchored' actually arrives, there will be hundreds of new reasons why there can be no exit just yet. The economy will be too weak, there might be a cash shortage, you name it. Just look at historical examples, it always happens in the same manner, more or less.

Bernanke's next proposal:


“A second policy option for the FOMC would be to ease financial conditions through its communication, for example, by modifying its post-meeting statement. As I noted, the statement currently reflects the FOMC's anticipation that exceptionally low rates will be warranted "for an extended period," contingent on economic conditions. A step the Committee could consider, if conditions called for it, would be to modify the language in the statement to communicate to investors that it anticipates keeping the target for the federal funds rate low for a longer period than is currently priced in markets. Such a change would presumably lower longer-term rates by an amount related to the revision in policy expectations.”


He may be overestimating the importance of the Fed's, well, blah-blah, here. The markets usually care about 'modified language'  for about three trading hours. Then it's back to square one. Neither will borrowers become eager to borrow, not will lenders become eager to lend more just because the FOMC statement contains 'modified language'. This is just a pipe dream. On the other hand, language can do no real economic harm (you can't bid for resources with language alone), so of all the Bernankian inflation plans, this seems the least harmful.

Next up:


“ A third option for further monetary policy easing is to lower the rate of interest that the Fed pays banks on the reserves they hold with the Federal Reserve System. Inside the Fed this rate is known as the IOER rate, the "interest on excess reserves" rate. The IOER rate, currently set at 25 basis points, could be reduced to, say, 10 basis points or even to zero. On the margin, a reduction in the IOER rate would provide banks with an incentive to increase their lending to nonfinancial borrowers or to participants in short-term money markets, reducing short-term interest rates further and possibly leading to some expansion in money and credit aggregates. However, under current circumstances, the effect of reducing the IOER rate on financial conditions in isolation would likely be relatively small. The federal funds rate is currently averaging between 15 and 20 basis points and would almost certainly remain positive after the reduction in the IOER rate. Cutting the IOER rate even to zero would be unlikely therefore to reduce the federal funds rate by more than 10 to 15 basis points. The effect on longer-term rates would probably be even less, although that effect would depend in part on the signal that market participants took from the action about the likely future course of policy. Moreover, such an action could disrupt some key financial markets and institutions. Importantly for the Fed's purposes, a further reduction in very short-term interest rates could lead short-term money markets such as the federal funds market to become much less liquid, as near-zero returns might induce many participants and market-makers to exit. In normal times the Fed relies heavily on a well-functioning federal funds market to implement monetary policy, so we would want to be careful not to do permanent damage to that market.”


We talked about this one before – it will make no difference to the banks afraid of a future liquidity crunch if the rate paid on their precautionary cash balances is 15 basis points higher or lower, given that it is already very low. However, what Bernanke did not mention is the possibility of introducing a penalty rate for excess reserves held at the Fed. We hereby predict that this will eventually be considered, as some Keynesian luminaries like Gregory Mankiw have already proposed the lunacy of negative interest rates in the past. We point to the debunking of this idea by Robert Murphy, which we have nothing to add to. However, just because a policy is completely crazy does not mean it won't be considered – in fact, the nuttier the idea, the more likely it will be considered. Anything to 'increase aggregate spending' and get banks to engage in inflationary loan and deposit creation!

Bernanke than briefly launches into the possibility of 'increasing the Fed's inflation target', which luckily for all of us he thinks has currently no support within the FOMC – unless of course 'inflation will become necessary to erase the effects of a period of deflation'. So even in the highly unlikely event of prices actually falling, they will then do whatever it takes to erase that! You couldn't make this nonsense up if you tried.

He then tells us what exactly would prompt the Fed to print even more (this includes the brief paragraph we already reproduced at the beginning of this post):


“Each of the tools that the FOMC has available to provide further policy accommodation–including longer-term securities asset purchases, changes in communication, and reducing the IOER rate–has benefits and drawbacks, which must be appropriately balanced. Under what conditions would the FOMC make further use of these or related policy tools? At this juncture, the Committee has not agreed on specific criteria or triggers for further action, but I can make two general observations.

First, the FOMC will strongly resist deviations from price stability in the downward direction. Falling into deflation is not a significant risk for the United States at this time, but that is true in part because the public understands that the Federal Reserve will be vigilant and proactive in addressing significant further disinflation. It is worthwhile to note that, if deflation risks were to increase, the benefit-cost tradeoffs of some of our policy tools could become significantly more favorable.  Second, regardless of the risks of deflation, the FOMC will do all that it can to ensure continuation of the economic recovery. Consistent with our mandate, the Federal Reserve is committed to promoting growth in employment and reducing resource slack more generally. Because a further significant weakening in the economic outlook would likely be associated with further disinflation, in the current environment there is little or no potential conflict between the goals of supporting growth and employment and of maintaining price stability.”


We already noted before that the belief that the Fed can somehow 'create growth in employment' is an example of magical thinking. 'Resource slack', i.e. the Keynesian concern with so-called 'idle resources' is worth being discussed in a separate blog post, and we will get around that in the future.

Let us note here only this much: there is a very good reason why certain resources are 'idle' and there is no way for a central planning agency to determine whether they should or shouldn't be 'un-idled'. First, the reason why certain resources  are now not used, is that they consist of malinvested capital for which no new uses could as yet be found due to it being highly specific. Think for instance about all the capital that has been invested along the entire latticework and chains of production structures concerned with home building. It should be obvious that given record low demand for both new and existing homes, there is absolutely no need to employ the specific factors that are surplus to the housing market's requirements in their former capacity. Entrepreneurs can only attempt to find new uses for these sunk cost items, and where such new – and profitable – uses can not be found, liquidation is the only option. Both the Fed with its heavy buying of mortgage securities and the treasury by dint of the plethora of housing market interventions it has undertaken to date, have delayed the necessary adjustments in this sector of the economy, and have thereby worsened the situation considerably. Unless the housing market is allowed to find its clearing level as quickly as possible, it is to be feared that even more scarce capital will be consumed.

The best way to deal with 'resource slack' is not to print more money, it is to give the free market the chance to adapt the production structure to the new circumstances the bust has revealed as quickly as possible. Every obstruction of this process, whether it is by direct interventions or more inflation, will only serve to delay genuine economic recovery.

As to Bernanke's deflation fear, it is utterly misguided. To quote Guido Hülsmann on the matter: “the dangers of deflation are chimerical, but its charms are very real.” Doug French recently published an article 'In Defense of Deflation' that we think is required reading for anyone that fears that 'deflation equals depression' – it is simply not true. What is true, is that a genuine deflation would alter the distribution of economic power – it would be antithetic to our entire 'spend now, pay later' system, and would never be accepted by the current ruling elite, as the 'free lunches' it has become accustomed to would definitely come to an end.



There were no surprises in Bernanke's speech. The man was, is, and will remain, a monetary crank who is dangerous to our economic well-being. There's one thing he knows how to do, and that is print more money. He isn't going to save the economy, and as we have noted before, the widely held conviction that he has 'averted another Great Depression' is lacking in proof. How would we know after a mere two years after the financial crisis? All we do know with certainty is that the money printing to date has not had a whole lot of effect in terms of generating economic growth, even by the absurd standards by which the government defines it. We know with absolute certainty that his polices have not created a single iota of genuine wealth, as this simply can not be done by printing more money. If it could, Zimbabwe would be a Utopia of riches as we often point out.

Given that the economy's foundations have been severely weakened by decades of loose monetary policy and given that the US pool of real funding is evidently in extremely poor shape following the most recent iteration of the great credit boom, we can already conclude that one or more of the policy options Bernanke mentions in his speech will be implemented. Should the stock market suffer a large fall, it becomes an absolute certainty. Therefore there remains little reason to look toward the longer term future with optimism. More scarce capital will be consumed and economic recovery will remain elusive just as it has remained elusive for two decades in Keynesianism-plagued Japan.



Fed chairman Bernanke: Yet another flood of money is already waiting in the wings, especially if prices should exhibit the pertinence of falling.

(Photo Credit: AP)




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One Response to “Bernanke at Jackson Hole”

  • Bearster:

    What’s amazing is that he incessantly jawbones about deflation without either defining the term or saying why it’s bad. If deflation is falling CPI, then the question is why would you risk destroying the currency and financial system to fight this?

    If deflation is falling asset prices, then it would be clear. Banks have “assets” to match their liabilities. But if the “assets” were to fall, say, 50%, and banks were to be leveraged, say, 10:1, then it would obvious that banks would be insolvent by a country mile.

    And of course only Austrians grasp that deflation is a decrease in the money supply (Mish adds an important point which is that this really means money+credit, and credit must be marked to market). Per above, since every penny of this credit is someone’s asset, then as this credit money goes away (by people defaulting on their loans), there is much pain to be felt.

    But this is merely the accounting reconciliation with the malinvested and consumed capital of the preceding boom. We destroyed a lot of real capital, and that is why we now face pain and more pain.

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